Last week the U.S. House of Representatives passed a bill to overhaul the tax code in our country. The plan is being branded as an attempt to simplify an overly complicated tax code that is rife with a million different deductions, complicated forms, and plenty of loopholes.
So is the plan good or bad? Well
, that depends on who you are, as there will be both winners and losers with this plan. Homeowners, and aspiring homeowners in the Orange County and Los Angeles areas will likely be marked as losers if this plan actually comes all the way to fruition.
So What Does this Plan Aim to Do?
On its face, the plan looks like a big tax break. It almost doubles the standard deduction, increasing it from $12,700 to $24,000 for a married couple. That’s a pretty substantial break for people in the lowest tax brackets. It also reduces the number of tax brackets from 7 down to 4. But, the most “expensive” part of this plan is the decrease in the corporate tax rate from 35% to 20%.
In order to pay for these tax breaks, Trump’s plan takes aim at many of the long-time real estate tax write offs that homeowners have long relied on to make home ownership affordable. If this plan were to go into effect, it would likely make homeownership more difficult for people to achieve, and would increase the tax burden for those that are already homeowners.
With that being said, let’s go into detail on how the plan affects homeowners.
5 Main Ways The Trump Plan Hurts Homeowners
1. Reducing the Mortgage Interest Deduction
This new tax plan aims to decrease the mortgage interest deduction from $1 million to $500,000. This means that you would only be able to write off the interest on the first $500,000 of your mortgage amount.
In most markets throughout the U.S. $500,000 will buy a luxury mansion. So, most Americans won’t see this reduction as a big deal. In Orange County and Los Angeles, however, you will be hard pressed to find a single family home in a good neighborhood for $500,000. In fact, the median home price in Orange County is just over $700,000.
The mortgage interest deduction is one of the big advantages to owning a home, and has actually helped many first time homeowners make the jump from renting to owning. The challenge many first time home buyers face in Southern California, is that mortgage payments to buy a home are generally higher than the rental rates for those same homes.
With the lower mortgage interest deduction, many families who have been getting ready to buy will now be faced with not only a higher monthly living expense, but no break on their taxes to help mitigate it. This will no doubt make homeownership more difficult, even impossible, for more people.
Mortgage Interest and the Standard Deduction
Another important thing to note is that with the low interest rate environment that we are in, it is pretty unlikely that the amount of interest paid on $500,000 would ever be higher than a new standard deduction of $24,000.
This means that even if a married couple was able to buy a house and only borrow $500,000, they are still unlikely to reap any tax benefit unless they have enough additional deductions to help them get over the $24,000 mark. Altogether, the higher standard deduction coupled with the limited mortgage interest deduction make it much more difficult for people to make the jump from renting to owning.
2. Limiting the Property Tax Deduction to $10,000
The Real Estate Property Tax deduction has historically been limited by a filers income, not the amount of the tax. While this reduction will also make buying a home more difficult relative to renting, there is another drawback: it decreases the desirability of higher priced and higher taxed neighborhoods.
The original idea of writing off property taxes was that citizens could avoid being taxed by the federal government on money that they already earned and used to pay taxes in their state. By reducing the amount of the property tax deduction, the government is effectively increasing the rate of “double taxation” on citizens that reside in areas with more expensive taxes.
Orange County is one of these areas that would see increased double taxation for home owners simply because real estate tends to be very expensive here. But, it doesn’t just take high values to hurt homeowners, just high taxes. City of Industry in LA County, for example has a tax rate of about 2%, while Hermosa Beach is closer to 1%. This means that a $1 million dollar home in Hermosa Beach would have the same tax write-off as a $500,000 home in City of Industry. This has the effect of dis-incentivizing would-be buyers from moving to City of Industry.
3. Stricter Requirements for Capital Gains Exemption
Traditionally, when a homeowner buys a house and sells it a few years later they can avoid paying capital gains taxes on up to $500,000 of appreciation on their home. The new tax plan makes some significant changes to the circumstances under which this can be done.
The first change is the amount of time that the you have owned and lived in the home. Originally, you were only required to have lived in the home for 2 of the last five years that you had owned it. This new tax plan proposed raising that requirement to 5 of the last 8 years.
Further, the new tax plan seeks to eliminate this exemption for homeowners that have a certain income. The exemption would phase out for single people making more than $250,000 and married couples making more than $500,000.
The net effect of this is that people who may want to move, may need to put those plans off if they need the money from their home sale to buy a new house. Instead of only needing to wait 2 years to avoid the hefty capital gains tax, they will now need to wait 5. This is sure to restrict more people from selling, exacerbate the low-inventory problem in the market, drive up prices, and ultimately make life harder for new and would-be home buyers.
4. Moving Expense Write-off is Gone
As it stands, you can write off your moving-related expenses. Under the new plan you will not be able to write off any moving expenses. Of course, the impact of losing this deduction will likely be pretty minimal, especially considering that the new standard deductions would be set at $12,000 and $24,000 respectively for single and married peoples.
5. Burdens Only Apply to non-Investors
Interestingly, while this tax plan does a lot to dis-incentivize homeownership and first-time home buyers, it looks wonderful for real estate investors. If you own an investment property through an LLC (almost all investors do) than there are no limits on how much interest or taxes you can write off. You also only pay a 25% income tax on the profits passed through the LLC.
This does make sense as taxes and interest would be considered business expenses, but it does seem unfortunate that the new plan does so much to hurt regular home owners while making life easier for real estate investors.
Conclusion
While the new tax plan on its face looks like it intends to lower taxes, it does so at the expense of many tax deductions that homeowners rely on. The problem with this is that most of the wealth generated by the middle class is through appreciation in home values.
Therefore, to make buying or selling a home more difficult for people in the middle and lower class in exchange for a slightly smaller tax bill seems like a short-sighted exercise in throwing good money after bad.
I also find the goal of this bill to be suspect. People across the board get marginal tax breaks, no doubt an attempt at buying broad support, but the real winner in this bill is big business as the corporate tax rate falls from 35% to 20%. Wow, and all these tax breaks are supposed to be paid for by taking away the real estate tax deductions that the middle class has relied upon for years to make the dream of home ownership an attainable reality.